What does deleveraging mean for the property market?

Leveraged beyond our means. That is the cause of the global financial crisis, according to The Age’s Ross Gittins.

“In the past decade, the housing boom — including the welter of negative gearing — has seen their total debt double relative to their disposable income from 80% to almost 160%.

That is our great vulnerability. If Australia succumbs to the global recession, excessive household borrowing will be the greatest reason.

You may say, rather, that the root cause of the global crisis is greed and its ultimate transformation into fear. But it’s borrowing that facilitates greed and excessive levels of debt that generate so much fear when boom turns to bust.”

“Leveraging” is what happens when you borrow a whole lot of money from your bank for the purpose of a house, with the hope that the value of that property will increase. When the price does rise, you use the equity in your home to buy more houses. Or a new boat.

Now imagine that going on right across Australia. Everything is well with the world, or so it seems.

But now, in 2008, we have hit the time for “deleveraging”. The banks have lost billions of dollars because of all that willy-nilly loanin’ they were doing, and they need to get their money back. Borrowers are forced to sell up, and when this happens on a major scale property prices are forced down. Banks are then left with homes that are not worth as much as they used to be, so they have to cut their credit by forcing more people to sell up in order to repay their mortgages, which in turn forces property prices down again. And the circle goes around.

Deleveraging by the banks has hit the USA hard, but it hasn’t yet kicked in for Australia. If it does, that’s when property prices will really start to fall. Fortunately the major banks in Australia are in a far stronger position than their American cousins, so we should be ok. However, it does mean that banks are unlikely to want to offer large mortgages in the current market, thereby limiting any possible real estate price surge.

At the personal level, deleveraging occurs when people realise they have to get rid of most or all of their debts. For real estate this means selling up and paying off the mortgage, leading to an abundance of homes on the market with the outcome being lower property prices. The sharp drop in interest rates over the past couple of months should help to minimise the amount of deleveraging by homeowners in Australia. With the monthly mortgage bill dropping, people might be able to get themselves through this tough financial time without having to sell the family home.